What is a Financial Statement?

Reading a financial statement for the first time can be extremely confusing. This is especially true if you are not financially or account training. However, reading a financial statement is an essential part of being an investor.

So how can we simplify the process? Here are some of the key things you need to look at when reading a financial statement.

Understand The Income Statement

The income statement is just a representation on how much the company made during a financial year. Typically, a financial year would be 12 months for a company. However, sometimes it can be extended to 15, 18 or even 21 months if the company is changing the date of its financial year recording.

The income statement starts with showing how much the company made from its sales and slowly deducting all its cost, line by line, and ends by showing how much the company earned net of all its expenses.

An income statement generally starts with the line “Revenue”.

Revenue shows how much the company generated from its sales, either by selling its products or serving its services. The direct cost of producing this product would then be subtracted to come up with the gross profit for the company.

After deducting other administrative, financial costs and taxes, the company would derive at its net profit, which is the profit made by the company net of all its expenses during the financial year.

Balance Sheet Is: Assets = Liabilities + Equities

The balance sheet of a company is just a snapshot of how healthy is the company at a point in time. That point is typically right at the end of the financial year for the company. The balance sheet is broken up into three segments; Assets, Liabilities and Equities.

The relationship between these three segments is that assets are equal to liabilities plus equities. As shareholders, we would need to know we are the equity holders of a company. Its assets are what the company owns. However, as an equity holder, we are only entitled to the equity portion of its balance sheet.

Cash Flow Is King

Lastly, the cash flow statement shows how the cash is moving within the company. Although the company can record how much it generated in sales and how much it earned during a year, that is different from how much cash is moving in and out of a company.

This is because as a company record sales, it might not have received the cash from the customers if it is giving them credit terms for payment. Again, if a company made an investment by buying a new factory, we do not see it in its income statement but there will be cash outflow from its cash flow statement. Here are the three main components of a cash flow statement.

Cash Flows From Operating Activities

It is the cash movement of the company from its operations during the financial period. A positive number means that cash is coming into the company while a negative number means cash is moving out of the company.

Cash Flows From Investing

Cash can move in and out of a company based on its investment decision. This can include capital expenditure, sales of assets, buying or selling of short-term assets and even dividends and interests from its stocks and bond investments. When a company buy a new factory, there will be a negative number. When it sells off its old machinery, there will be a positive number.

Cash Flows From Financing Activities

Here, the cash movement of the company changes due to its financing inflow and payoff. As a company takes on more debt, there will be a positive number. When it pays out a dividend, there will be a negative number.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.